What are smart contracts?
A smart contract is similar to any other contract in that it binds two or more parties to an agreement. The key difference is that instead of requiring lawyers or other intermediaries to ensure that the terms of the contract are met, a smart contract is executed, and verified, automatically and instantly by a blockchain-based computer programme. All participants in the contract are immediately certain of the outcome, and it is irreversible.
An example of a smart contract
Smart contracts can be applied to any agreement. If you buy or sell a house, for example, the costs can quickly pile up from a number of intermediaries involved, from getting a mortgage approved to transferring ownership. Many of these processes can be automated using smart contracts.
A lender such as a bank, for example, can provide smart contract mortgages which pay out once certain pre-existing parameters are met by a loan applicant, such as Alice in the example below.
The smart contract can process and confirm proof of income and assets, along with other checks and balances that a lawyer or another third-party would usually have to verify, after which the loan can automatically be paid to Alice.
A blockchain removes the need for an intermediary as it completely removes trust from the equation, seeing that all the information is stored on a tamper-proof blockchain and computer code executes the contract.
While these smart contracts each perform a certain function, decentralised applications (dApps) often combine many smart contracts to perform sophisticated actions in one application.
Where are smart contracts built?
Smart contracts are built on blockchains – the technology that powers cryptocurrencies like Ethereum – that are specifically designed to accommodate these types of programmes. Programmable blockchains are able to house both transaction information, as is the case with any blockchain, but also the computer programme that runs a smart contract.
NFTs as smart contracts
NFTs are minted on a blockchain using smart contracts. Each time someone loads an NFT onto a cryptocurrency blockchain, or ‘mints it’, a smart contract is created. Think of it like a vending machine for NFTs. You put money in, take your pick, and the machine hands you your order.
The smart contract automatically records the details of each transaction, assigns ownership and ensures that the crypto is debited and credited from the relevant wallets. This happens without the involvement of a Sotheby’s or another broker, or a bank, for that matter.